Fed Hikes 25bps, Signals a Lukewarm Pause

Fed Hikes 25bps, Signals a Lukewarm Pause

Meeting Highlights:

• The Fed raised the overnight target rate by 25bps to 5.00% – 5.25%, matching the market consensus. Meanwhile, the Fed also signaled a pause on future hikes for an indefinite time. The statement amended its language as to future rate hikes to: “In determining the extent to which additional policy firming may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.” So, just as we suspected, it’s a pause but with plenty of caveats from the Fed that could get them hiking again at some point in the future. That may be why today’s vote was unanimous despite some voices on the Fed that have been calling for additional rate hikes.

• Since this was not a quarter-end meeting there were no updated economic or rate forecasts. The only information coming from the meeting is the attached statement and the post-meeting press conference where Powell will add more color to today’s decision.

• Futures pricing prior to the announcement had the median terminal rate of 5.05% with 67bps of rate cuts by year-end. Those futures levels continue to be mostly held in early post-meeting trading. In the Fed’s March forecast, they have rate cuts beginning in 2024 with the median rate at 4.25% by the end of that year. There is, however, a wide range within the committee where 2024 ends with a high of 5.625% and a low of 3.375%.

• In the March forecast, the Fed saw core PCE ending 2023 at 3.6% then dropping to 2.6% in 2024. It currently stands at 4.6% and was 5.0% a year ago, so the decrease in core PCE has been very grudging. If that continues through 2023 the Fed may be compelled to reinitiate rate hikes, and certainly not seek to cut rates. Thus, we see the Fed continuing to pushback on the market’s forecast of rate cuts later this year. If the market starts to believe that scenario, then shorter-term rates will increase off the higher-for-longer rate path.

• The Fed acknowledges there remains more work to do on the inflation battle, but the banking turmoil that erupted in March, and continued to a lesser extent in April, has certainly complicated matters. There’s no doubt been some credit tightening in the wake of the turmoil but to what extent is still largely unknown. The Fed’s quarterly Senior Loan Officer Survey will be out next week and will provide additional insight, but that comes too late for this meeting. Actual lending and economic activity will be watched closely over the next several months for the degree of contraction and hence economic slowing.

• Overall, the Fed delivered the expected 25bps hike and signaled that a pause would be forthcoming. But that pause comes with plenty of caveats that make a resumption of rate hikes possible if the inflation data doesn’t cooperate, and economic activity remains resilient in the face of the cumulative rate hikes and the volatility from the banking turmoil. Call it a hawkish pause but Treasuries are holding much of the gains prior to the meeting. Now they must negotiate the Powell press conference. The bottom line is there is still a disconnect between the Fed and the market as to when rate cuts will commence. For now, the market still seems comfortable with their expectations and the Fed sees no reason to move their expectation of rate cuts forward, so the standoff continues.

Official FOMC Statement

https://www.federalreserve.gov/monetarypolicy/files/monetary20230503a1.pdf